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DANAHER CORP /DE/ - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is designed to provide a reader of Danaher Corporation's ("Danaher," the "Company," "we," "us" or "our") financial statements with a narrative from the perspective of Company management. The Company's MD&A is divided into four main sections: • Information Relating to Forward-Looking Statements • Overview • Results of Operations • Liquidity and Capital Resources You should read this discussion along with the Company's MD&A and audited financial statements as of and for the year ended December 31, 2013 and Notes thereto, included in the Company's 2013 Annual Report on Form 10-K, and the Company's Consolidated Condensed Financial Statements and related Notes as of and for the three months ended March 28, 2014. INFORMATION RELATING TO FORWARD-LOOKING STATEMENTS Certain statements included or incorporated by reference in this quarterly report, in other documents we file with or furnish to the Securities and Exchange Commission ("SEC"), in our press releases, webcasts, conference calls, materials delivered to shareholders and other communications, are "forward-looking statements" within the meaning of the United States federal securities laws. All statements other than historical factual information are forward-looking statements, including without limitation statements regarding: projections of revenue, expenses, profit, profit margins, tax rates, tax provisions, cash flows, pension and benefit obligations and funding requirements, our liquidity position or other projected financial measures; management's plans and strategies for future operations, including statements relating to anticipated operating performance, cost reductions, restructuring activities, new product and service developments, competitive strengths or market position, acquisitions, divestitures, strategic opportunities, securities offerings, stock repurchases, dividends and executive compensation; growth, declines and other trends in markets we sell into; new or modified laws, regulations and accounting pronouncements; outstanding claims, legal proceedings, tax audits and assessments and other contingent liabilities; foreign currency exchange rates and fluctuations in those rates; general economic and capital markets conditions; the timing of any of the foregoing; assumptions underlying any of the foregoing; and any other statements that address events or developments that Danaher intends or believes will or may occur in the future. Terminology such as "believe," "anticipate," "should," "could," "intend," "plan," "expect," "estimate," "project," "target," "may," "possible," "potential," "forecast" and "positioned" and similar references to future periods are intended to identify forward-looking statements, although not all forward-looking statements are accompanied by such words. Forward-looking statements are based on assumptions and assessments made by our management in light of their experience and perceptions of historical trends, current conditions, expected future developments and other factors they believe to be appropriate. Forward-looking statements are not guarantees of future performance and actual results may differ materially from the results, developments and business decisions contemplated by our forward-looking statements. Accordingly, you should not place undue reliance on any such forward-looking statements. Important factors that could cause actual results to differ materially from those envisaged in the forward-looking statements include the following: • Conditions in the global economy, the markets we serve and the financial markets may adversely affect our business and financial statements. • Our restructuring actions could have long-term adverse effects on our business. • Our growth could suffer if the markets into which we sell our products (including software) and services decline, do not grow as anticipated or experience cyclicality. • We face intense competition and if we are unable to compete effectively, we may experience decreased demand and decreased market share. Even if we compete effectively, we may be required to reduce prices for our products and services. • Our growth depends in part on the timely development and commercialization, and customer acceptance, of new and enhanced products and services based on technological innovation. • Our reputation, ability to do business and financial statements may be impaired by improper conduct by any of our employees, agents or business partners. 16-------------------------------------------------------------------------------- Table of Contents • Any inability to consummate acquisitions at our historical rate and at appropriate prices could negatively impact our growth rate and stock price. • Our acquisition of businesses, joint ventures and strategic relationships could negatively impact our financial statements. • The indemnification provisions of acquisition agreements by which we have acquired companies may not fully protect us and as a result we may face unexpected liabilities. • Divestitures could negatively impact our business, and contingent liabilities from businesses that we have sold could adversely affect our financial statements. • Certain of our businesses are subject to extensive regulation by the U.S. Food and Drug Administration ("FDA") and by comparable agencies of other countries, as well as laws regulating fraud and abuse in the healthcare industry and the privacy and security of health information. Failure to comply with those regulations could adversely affect our reputation and financial statements. • The healthcare industry and related industries that we serve have undergone, and are in the process of undergoing, significant changes in an effort to reduce costs, which could adversely affect our financial statements. • Our operations, products and services expose us to the risk of environmental, health and safety liabilities, costs and violations that could adversely affect our reputation and financial statements. • Our businesses are subject to extensive regulation; failure to comply with those regulations could adversely affect our financial statements and reputation. • We may be required to recognize impairment charges for our goodwill and other intangible assets. • Foreign currency exchange rates may adversely affect our financial statements. • Changes in our tax rates or exposure to additional tax liabilities or assessments could affect our profitability. In addition, audits by tax authorities could result in additional tax payments for prior periods. • We are subject to a variety of litigation and other legal and regulatory proceedings in the course of our business that could adversely affect our financial statements. • If we do not or cannot adequately protect our intellectual property, or if third parties infringe our intellectual property rights, we may suffer competitive injury or expend significant resources enforcing our rights. • Third parties may claim that we are infringing or misappropriating their intellectual property rights and we could suffer significant litigation expenses, losses or licensing expenses or be prevented from selling products or services. • Defects and unanticipated use or inadequate disclosure with respect to our products (including software) or services could adversely affect our business, reputation and financial statements. • The manufacture of many of our products is a highly exacting and complex process, and if we directly or indirectly encounter problems manufacturing products, our reputation, business and financial statements could suffer. • Our indebtedness may limit our operations and our use of our cash flow, and any failure to comply with the covenants that apply to our indebtedness could adversely affect our liquidity and financial statements. • Adverse changes in our relationships with, or the financial condition, performance, purchasing patterns or inventory levels of, key distributors and other channel partners could adversely affect our financial statements. • Our financial results are subject to fluctuations in the cost and availability of commodities that we use in our operations. 17-------------------------------------------------------------------------------- Table of Contents • If we cannot adjust our manufacturing capacity or the purchases required for our manufacturing activities to reflect changes in market conditions and customer demand, our profitability may suffer. In addition, our reliance upon sole or limited sources of supply for certain materials, components and services could cause production interruptions, delays and inefficiencies. • Changes in governmental regulations may reduce demand for our products or services or increase our expenses. • Work stoppages, union and works council campaigns and other labor disputes could adversely impact our productivity and results of operations. • International economic, political, legal, compliance and business factors could negatively affect our financial statements and in particular geopolitical uncertainties relating to Russia could impact the Company's growth in Russia. • If we suffer loss to our facilities, supply chains, distribution systems or information technology systems due to catastrophe or other events, our operations could be seriously harmed. • A significant disruption in, or breach in security of, our information technology systems could adversely affect our business. • Our defined benefit pension plans are subject to financial market risks that could adversely affect our financial statements. See Part I - Item 1A of the Company's 2013 Annual Report on Form 10-K for a further discussion regarding reasons that actual results may differ materially from the results, developments and business decisions contemplated by our forward-looking statements. Forward-looking statements speak only as of the date of the report, document, press release, webcast, call, materials or other communication in which they are made. We do not assume any obligation to update or revise any forward-looking statement, whether as a result of new information, future events and developments or otherwise. OVERVIEW General As a result of the Company's geographic and industry diversity, the Company faces a variety of opportunities and challenges, including rapid technological development (particularly with respect to computing, mobile connectivity, communications and digitization) in most of the Company's served markets, the expansion and evolution of opportunities in high-growth markets, trends and costs associated with a global labor force, consolidation of the Company's competitors and increasing regulation. The Company defines high-growth markets as developing markets of the world experiencing rapid growth in gross domestic product and infrastructure which includes Eastern Europe, the Middle East, Africa, Latin America and Asia with the exception of Japan and Australia. The Company operates in a highly competitive business environment in most markets, and the Company's long-term growth and profitability will depend in particular on its ability to expand its business in high-growth geographies and high-growth market segments, identify, consummate and integrate appropriate acquisitions, develop innovative and differentiated new products, services and software with higher gross profit margins, expand and improve the effectiveness of the Company's sales force, continue to reduce costs and improve operating efficiency and quality, and effectively address the demands of an increasingly regulated environment. The Company is making significant investments, organically and through acquisitions, to address the rapid pace of technological change in its served markets and to globalize its manufacturing, research and development and customer-facing resources (particularly in high-growth markets) in order to be responsive to the Company's customers throughout the world and improve the efficiency of the Company's operations. Business Performance and Outlook While differences exist among the Company's businesses, on an overall basis, demand for the Company's products and services increased during the first quarter of 2014 as compared to the comparable period of 2013 resulting in aggregate year-over-year sales growth from existing businesses of 3.5%. In addition, the Company's continued investments in sales growth initiatives and other business-specific factors discussed below contributed to year-over-year sales growth. Geographically, year-over-year sales growth rates from existing businesses during the first quarter of 2014 were led primarily by the high-growth markets. Sales from existing businesses in high-growth markets grew at a high-single digit rate in the first quarter of 2014 as compared to the comparable period of 2013 and represented approximately 25% of the Company's total sales in the first quarter of 2014. Sales from existing businesses in developed markets grew at a low-single digit rate in the first quarter of 2014 as compared to the comparable period of 2013 due primarily to growth in North America, Japan and Europe, representing the third consecutive 18 -------------------------------------------------------------------------------- Table of Contents quarter of growth in Europe. The Company expects overall market conditions to continue to improve, but remains cautious about challenges due to macro-economic and geopolitical uncertainties and monetary and fiscal policies of countries where we do business. While individual businesses will vary, the Company expects sales from existing businesses to continue to grow on a year-over-year basis during the remainder of 2014 at a level in line with that experienced in the first quarter of 2014. Acquisitions During the first three months of 2014, the Company acquired five businesses for total consideration of $163 million in cash, net of cash acquired. The businesses acquired complement existing units of the Environmental and Test & Measurement segments. The aggregate annual sales of these five businesses at the time of their respective acquisitions, in each case based on the company's revenues for its last completed fiscal year prior to the acquisition, were approximately $65 million. Currency Exchange Rates Currency exchange rates negatively impacted reported sales for the three month period by approximately 0.5% on a year-over-year basis as the U.S. dollar was, on average, stronger against other major currencies during the first three months of 2014 as compared to exchange rate levels during the first three months of 2013, with the exception of the Euro and the Chinese Yuan. If the currency exchange rates in effect as of March 28, 2014 were to prevail throughout the remainder of 2014, currency exchange rates would have a negligible impact on the Company's estimated 2014 sales. Any strengthening of the U.S. dollar against other major currencies would adversely impact the Company's sales and results of operations for the remainder of the year. Any weakening of the U.S. dollar against other major currencies would positively impact the Company's sales and results of operations on an overall basis. RESULTS OF OPERATIONS Consolidated sales for the three months ended March 28, 2014 increased 5.0% compared to the three months ended March 29, 2013. Sales from existing businesses accelerated during the quarter contributing 3.5% growth, and sales from acquired businesses contributed 2.0% growth on a year-over-year basis. Currency translation reduced reported sales by 0.5% on a year-over-year basis. In this report, references to sales from existing businesses refers to sales calculated according to generally accepted accounting principles in the United States ("GAAP") but excluding (1) sales from acquired businesses and (2) the impact of currency translation. References to sales or operating profit attributable to acquisitions or acquired businesses refer to GAAP sales or operating profit, as applicable, from acquired businesses recorded prior to the first anniversary of the acquisition less the impact from the divestiture of a product line, the sales from which (prior to the divestiture) were included in sales from acquired businesses. The portion of revenue attributable to currency translation is calculated as the difference between (a) the period-to-period change in revenue (excluding sales from acquired businesses) and (b) the period-to-period change in revenue (excluding sales from acquired businesses) after applying current period foreign exchange rates to the prior year period. Sales from existing businesses should be considered in addition to, and not as a replacement for or superior to, sales, and may not be comparable to similarly titled measures reported by other companies. Management believes that reporting the non-GAAP financial measure of sales from existing businesses provides useful information to investors by helping identify underlying growth trends in our business and facilitating easier comparisons of our revenue performance with our performance in prior and future periods and to our peers. The Company excludes the effect of currency translation from sales from existing businesses because currency translation is not under management's control, is subject to volatility and can obscure underlying business trends, and excludes the effect of acquisitions and related items because the nature, size and number of acquisitions can vary dramatically from period to period and between the Company and its peers and can also obscure underlying business trends and make comparisons of long-term performance difficult. References to sales volume refer to the impact of both price and unit sales. Operating profit margins were 16.9% for the three months ended March 28, 2014 as compared to 16.4% in the comparable period of 2013. The following factors impacted year-over-year operating profit margin comparisons. 2014 vs. 2013 operating profit margin comparisons were favorably impacted by: • Higher 2014 sales volumes and incremental year-over-year cost savings associated with the restructuring actions and continuing productivity improvement initiatives taken in 2013, net of incremental year-over-year costs associated with various new product development, sales and marketing growth investments - 100 basis points 2014 vs. 2013 operating profit margin comparisons were unfavorably impacted by: • The incremental net dilutive effect of acquired businesses in 2014 - 50 basis points 19-------------------------------------------------------------------------------- Table of Contents Business Segments The following table summarizes sales by business segment for each of the periods indicated ($ in millions): Three Months Ended March 28, 2014 March 29, 2013 Test & Measurement $ 871.0 $ 855.4 Environmental 768.7 725.3 Life Sciences & Diagnostics 1,659.6 1,567.4 Dental 509.7 479.8 Industrial Technologies 853.7 816.8 Total $ 4,662.7 $ 4,444.7 TEST & MEASUREMENT The Company's Test & Measurement segment is a leading global provider of electronic measurement instruments, professional test tools, thermal imaging and calibration equipment used in electrical, industrial, electronic and calibration applications. Danaher offers test, measurement and monitoring products that are used in electronic design, manufacturing and advanced technology development; network monitoring, management and optimization tools; and security solutions for communications and enterprise networks. Customers for these products and services include manufacturers of electronic instruments; service, installation and maintenance professionals; manufacturers who design, develop, manufacture and deploy network equipment; and service providers who implement, maintain and manage communications networks and services. Also included in the Test & Measurement segment are the Company's mobile tool and wheel service businesses. Test & Measurement Selected Financial Data ($ in millions): Three Months Ended March 28, 2014 March 29, 2013 Sales $ 871.0 $ 855.4 Operating profit 192.7 187.3 Depreciation and amortization 33.2 33.8 Operating profit as a % of sales 22.1 % 21.9 % Depreciation and amortization as a % of sales 3.8 % 4.0 % % Change Three Months Ended March 28, 2014 vs. Components of Sales Growth Comparable 2013 Period Existing businesses 1.0 % Acquisitions 1.0 % Currency exchange rates - % Total 2.0 % Year-over-year price increases in the segment had a negligible impact on sales during the three months ended March 28, 2014. Sales from existing businesses in the segment's instruments businesses grew at a low-single digit rate during the three months ended March 28, 2014 as compared to the comparable period of 2013, with increased year-over-year demand for industrial and calibration products. Demand in the high-growth markets led the increased year-over-year sales, while demand continued to stabilize in Europe and declined in North America, due primarily to weakness in the U.S. government and military end markets. 20 -------------------------------------------------------------------------------- Table of Contents Sales from existing businesses in the segment's communications businesses grew at a low-single digit rate during the three months ended March 28, 2014 as compared to the comparable period of 2013 driven by solid growth in network enterprise and network management solutions, partially offset by declines in network security and analysis solutions. The first quarter 2014 growth rate reflects a deceleration compared to 2013. The Company expects this trend to continue in the near term primarily due to the timing of network management projects as compared to the prior year. Geographically, year-over-year sales growth was strong in North America and Asia, somewhat offset by declines in Western Europe. Operating profit margins increased 20 basis points during the three months ended March 28, 2014 as compared to the comparable period of 2013. The following factors impacted year-over-year operating profit margin comparisons. 2014 vs. 2013 operating profit margin comparisons were favorably impacted by: • Higher 2014 sales volumes and incremental year-over-year cost savings associated with the restructuring actions and continuing productivity improvement initiatives taken in 2013, net of incremental year-over-year costs associated with various new product development, sales and marketing growth investments - 125 basis points 2014 vs. 2013 operating profit margin comparisons were unfavorably impacted by: • The incremental net dilutive effect of acquired businesses in 2014 - 105 basis points ENVIRONMENTALThe Company's Environmental segment provides products that help protect the water supply and air quality by serving two primary markets: water quality and retail/commercial petroleum. Danaher's water quality business is a global leader in water quality analysis and treatment, providing instrumentation and disinfection systems to help analyze and manage the quality of ultra pure water, potable water, wastewater, groundwater and ocean water in residential, commercial, industrial and natural resource applications. Danaher's retail/commercial petroleum business is a leading worldwide provider of solutions and services focused on fuel dispensing, remote fuel management, point-of-sale systems, payment systems, environmental compliance, vehicle tracking and fleet management. Environmental Selected Financial Data ($ in millions): Three Months Ended March 28, 2014 March 29, 2013 Sales $ 768.7 $ 725.3 Operating profit 145.6 135.1 Depreciation and amortization 18.0 13.2 Operating profit as a % of sales 18.9 % 18.6 % Depreciation and amortization as a % of sales 2.3 % 1.8 % % Change Three Months Ended March 28, 2014 vs. Components of Sales Growth Comparable 2013 Period Existing businesses 4.0 % Acquisitions 2.5 % Currency exchange rates (0.5 )% Total 6.0 % Year-over-year price increases in the segment contributed 1.0% to sales growth during the three months ended March 28, 2014 and are reflected as a component of the change in sales from existing businesses. Sales from existing businesses in the segment's water quality businesses grew at a low-single digit rate during the three months ended March 28, 2014 as compared to the comparable period of 2013. Sales growth in the analytical instrumentation business was led primarily by strong sales of consumables and related service in North America, Western Europe and China. Sales in the business' chemical treatment solutions product line also grew on a year-over-year basis during the three months due primarily to continued sales force investments in the U.S. market, and to a lesser extent, continued international expansion. 21 -------------------------------------------------------------------------------- Table of Contents Year-over-year sales from existing businesses in the business' ultraviolet water disinfection product line declined during the first three months of 2014 due to continued weak demand in municipal end markets, primarily in North America and Western Europe. Sales from existing businesses in the segment's retail petroleum equipment businesses grew at a mid-single digit rate during the three months ended March 28, 2014 as compared to the comparable period of 2013. On a year-over-year basis, the business experienced strong increase in global demand for its point-of-sale solutions, payment systems, and services, as well as dispenser sales in Western Europe and China. This growth was partially offset by a decline in demand for dispensers in North America. Operating profit margins increased 30 basis points during the three months ended March 28, 2014 as compared to the comparable period of 2013. The following factors impacted year-over-year operating profit margin comparisons. 2014 vs. 2013 operating profit margin comparisons were favorably impacted by: • Higher 2014 sales volumes and incremental year-over-year cost savings associated with the restructuring actions and continuing productivity improvement initiatives taken in 2013, net of incremental year-over-year costs associated with various new product development, sales and marketing growth investments and increased depreciation and amortization from prior year acquisitions - 145 basis points 2014 vs. 2013 operating profit margin comparisons were unfavorably impacted by: • The incremental net dilutive effect of acquired businesses in 2014 - 115 basis points LIFE SCIENCES & DIAGNOSTICS The Company's diagnostics businesses offer a broad range of analytical instruments, reagents, consumables, software and services that hospitals, physician's offices, reference laboratories and other critical care settings use to diagnose disease and make treatment decisions. The Company's life sciences businesses offer a broad range of research and clinical tools that scientists use to study cells and cell components to understand the causes of disease, identify new therapies and test new drugs and vaccines. Life Sciences & Diagnostics Selected Financial Data ($ in millions): Three Months Ended March 28, 2014 March 29, 2013 Sales $ 1,659.6 $ 1,567.4 Operating profit 219.7 199.3 Depreciation and amortization 128.8 125.2 Operating profit as a % of sales 13.2 % 12.7 % Depreciation and amortization as a % of sales 7.8 % 8.0 % % Change Three Months Ended March 28, 2014 vs. Components of Sales Growth Comparable 2013 Period Existing businesses 4.0 % Acquisitions 2.5 % Currency exchange rates (0.5 )% Total 6.0 % Year-over-year price increases in the segment had a negligible impact on sales during the three months ended March 28, 2014. Sales from existing businesses in the segment's diagnostics business grew at a low-single digit rate during the three months ended March 28, 2014 as compared to the comparable period of 2013, primarily due to strong demand in the acute care and pathology diagnostic businesses and, to a lesser extent, the clinical business. Demand in the clinical business increased on a year over-year-basis led by strong demand in the high-growth markets, largely offset by year-over-year declines in demand in North America and Europe, driven by decreased utilization in these regions and one less selling day in the quarter as compared 22 -------------------------------------------------------------------------------- Table of Contents to the comparable period of 2013. Year-over-year sales growth in the acute care diagnostic business was driven primarily by continued strong global consumable sales related to the installed base of acute care instruments. Geographically, this business' year-over-year sales growth was led by China, the Middle East and Japan which was somewhat offset by year-over-year declines in North America and Western Europe. The majority of the year-over-year sales growth in the pathology diagnostics business was driven by increased demand for advanced staining systems and consumables in Western Europe and China. Sales from existing businesses in the segment's life sciences businesses grew at a mid-single digit rate during the three months ended March 28, 2014 as compared to the comparable period of 2013, due primarily to continued strong demand for the business' recently introduced products. Sales of the business' broad range of mass spectrometers continued to grow on a year-over-year basis led by North America and Europe. Sales of surgical and stereo microscopy products increased on a year-over-year basis due primarily to strong demand in high-growth markets and Japan. The business' flow cytometry and sample preparation product lines also contributed to the year-over-year growth, with growth in all major geographies. Operating profit margins increased 50 basis points during the three months ended March 28, 2014 as compared to the comparable period of 2013. The following factors impacted year-over-year operating profit margin comparisons. 2014 vs. 2013 operating profit margin comparisons were favorably impacted by: • Higher 2014 sales volumes and incremental year-over-year cost savings associated with the restructuring actions and continuing productivity improvement initiatives taken in 2013, net of incremental year-over-year costs associated with various new product development, sales and marketing growth investments - 75 basis points 2014 vs. 2013 operating profit margin comparisons were unfavorably impacted by: • The incremental net dilutive effect of acquired businesses in 2014 - 25 basis points DENTALThe Company's Dental segment is a leading worldwide provider of a broad range of dental consumables, equipment and services that are used to diagnose, treat and prevent disease and ailments of the teeth, gums and supporting bone, and to improve the aesthetics of the human smile. The Company is dedicated to driving technological innovations that help dental professionals improve clinical outcomes and enhance productivity. Dental Selected Financial Data ($ in millions): Three Months Ended March 28, 2014 March 29, 2013 Sales $ 509.7 $ 479.8 Operating profit 75.5 62.9 Depreciation and amortization 20.5 20.9 Operating profit as a % of sales 14.8 % 13.1 % Depreciation and amortization as a % of sales 4.0 % 4.4 % % Change Three Months Ended March 28, 2014 vs. Components of Sales Growth Comparable 2013 Period Existing businesses 6.0 % Acquisitions - % Currency exchange rates - % Total 6.0 % Year-over-year price increases in the segment had a negligible impact on sales during the three months ended March 28, 2014. 23 -------------------------------------------------------------------------------- Table of Contents Sales from existing businesses in the dental segment grew at a mid-single digit rate during the three months ended March 28, 2014 as compared to the comparable period of 2013 primarily as a result of increased sales of professional dental consumables, implant and orthodontic products in all major geographies and continued increased demand for imaging products and treatment units in North America, high-growth markets and Japan, ahead of its April 1, 2014 value added tax rate increase. Operating profit margins increased 170 basis points during the three months ended March 28, 2014 as compared to the comparable period of 2013. Higher 2014 sales volumes and incremental year-over-year cost savings associated with the restructuring actions and continuing productivity improvement initiatives taken in 2013, net of incremental year-over-year costs associated with various new product development, sales and marketing growth investments, favorably impacted operating profit margin comparisons. INDUSTRIAL TECHNOLOGIES The Company's Industrial Technologies segment is a leading global provider of equipment, consumables and software for various printing, marking, coding, design and color management applications on consumer and industrial products. The segment is also a leading global provider of electromechanical motion control solutions for the industrial automation and packaging markets. In addition to the product identification and motion strategic lines of business, the segment also includes Danaher's sensors and controls, energetic materials and engine retarder businesses. Industrial Technologies Selected Financial Data ($ in millions): Three Months Ended March 28, 2014 March 29, 2013 Sales $ 853.7 $ 816.8 Operating profit 191.7 170.9 Depreciation and amortization 22.4 21.8 Operating profit as a % of sales 22.5 % 20.9 % Depreciation and amortization as a % of sales 2.6 % 2.7 % % Change Three Months Ended March 28, 2014 vs. Components of Sales Growth Comparable 2013 Period Existing businesses 3.0 % Acquisitions 1.0 % Currency exchange rates 0.5 % Total 4.5 % Price increases in the segment contributed 1.0% to sales growth on a year-over-year basis during the three months ended March 28, 2014 and are reflected as a component of the change in sales from existing businesses. Sales from existing businesses in the segment's motion businesses declined at a low-single digit rate during the three months ended March 28, 2014 as compared to the comparable period of 2013. Improving year-over-year demand in the distribution market, primarily in North America, was more than offset by soft demand in technology, defense and industrial automation related end-markets, and the impact of exiting certain low-margin original equipment manufacturers product lines. Year-over-year growth rates for the motion businesses are expected to continue to improve during 2014. Sales from existing businesses in the segment's product identification businesses grew at a mid-single digit rate during the three months ended March 28, 2014 as compared to the comparable period of 2013. Continued increased demand for marking and coding equipment and related consumables as well as packaging and color solutions in most major end-markets was partially offset by lower year-over-year demand in consumer electronics related equipment. Geographically, year-over-year sales growth was strong in North America, Europe and Latin America. 24 -------------------------------------------------------------------------------- Table of Contents Sales from existing businesses in the segment's other businesses collectively grew at a mid-single digit rate during the three months ended March 28, 2014 as compared to the comparable period of 2013, primarily due to strong demand in the segment's engine retarder business. Sales from existing businesses in the segment's sensors and controls businesses were essentially flat on a year-over-year basis. Operating profit margins increased 160 basis points during the three months ended March 28, 2014 as compared to the comparable period of 2013. The following factors impacted year-over-year operating profit margin comparisons. 2014 vs. 2013 operating profit margin comparisons were favorably impacted by: • Higher 2014 sales volumes and incremental year-over-year cost savings associated with the restructuring actions and continuing productivity improvement initiatives taken in 2013, net of incremental year-over-year costs associated with various new product development, sales and marketing growth investments - 185 basis points 2014 vs. 2013 operating profit margin comparisons were unfavorably impacted by: • The incremental net dilutive effect of acquired businesses in 2014 - 25 basis points COST OF SALES AND GROSS PROFIT ($ in millions) Three Months Ended March 28, 2014 March 29, 2013 Sales $ 4,662.7 $ 4,444.7 Cost of sales (2,209.8 ) (2,119.0 ) Gross profit 2,452.9 2,325.7 Gross profit margin 52.6 % 52.3 % The year-over-year increase in gross profit margins during the three month period ended March 28, 2014 as compared to the comparable period in 2013, is due primarily to the favorable impact of higher year-over-year sales volumes, incremental year-over-year cost savings associated with 2013 restructuring activities and continued productivity improvements. OPERATING EXPENSES ($ in millions) Three Months Ended March 28, 2014 March 29, 2013 Sales $ 4,662.7 $ 4,444.7 Selling, general and administrative ("SG&A") expenses 1,350.6 1,298.4 Research and development ("R&D") expenses 313.4 296.4 SG&A as a % of sales 29.0 % 29.2 % R&D as a % of sales 6.7 % 6.7 % Selling, general and administrative expenses as a percentage of sales declined 20 basis points on a year-over-year basis during the three month period ended March 28, 2014. Incremental year-over-year increases in investments in sales and marketing growth initiatives were offset by increased leverage of the Company's general and administrative cost base resulting from higher first quarter 2014 sales and incremental year-over-year cost savings associated with 2013 restructuring activities. Research and development expenses (consisting principally of internal and contract engineering personnel costs) as a percentage of sales were consistent on a year-over-year basis during the first three months of 2014 as compared to 2013. INTEREST COSTS AND FINANCING For a discussion of the Company's outstanding indebtedness, refer to Note 6 of the Consolidated Condensed Financial Statements. 25 -------------------------------------------------------------------------------- Table of Contents Interest expense of $33 million for the three months ended March 28, 2014 was $6 million lower than the comparable period of 2013. The decrease in interest expense results primarily from the repayment of the €500 million principal amount of Eurobond notes due 2013 and the $300 million principal amount of floating rate senior notes due 2013 upon maturity in July and June 2013, respectively. INCOME TAXES The Company's effective tax rate for the three months ended March 28, 2014 and March 29, 2013 was 23.9% and 25.0%, respectively. The Company's effective tax rate for 2014 and 2013 differs from the U.S. federal statutory rate of 35% due principally to the Company's earnings outside the United States that are indefinitely reinvested and taxed at rates lower than the U.S. federal statutory rate. The effective tax rate for the three months ended March 28, 2014 includes tax effects of certain discrete items specific to the quarter, none of which are significant individually or in the aggregate. During the three months ended March 29, 2013, the Company's gain on the sale of the Apex joint venture increased the reported tax rate by 3.5%, which was partially offset by the retroactive reinstatement of certain tax benefits and credits from the enactment of the American Tax Relief Act of 2012. The Company conducts business globally and files numerous consolidated and separate income tax returns in the United States federal, state and foreign jurisdictions. The countries in which the Company has a material presence that have significantly lower statutory tax rates than the United States include China, Denmark, Germany and the United Kingdom. The Company's ability to obtain a tax benefit from lower statutory tax rates outside of the United States is dependent on its levels of taxable income in these foreign countries. The Company believes that a change in the statutory tax rate of any individual foreign country would not have a material effect on the Company's financial statements given the dispersion of the Company's foreign income tax provision. The Company and its subsidiaries are routinely examined by various domestic and international taxing authorities. The Internal Revenue Service ("IRS") has completed examinations of certain of the Company's federal income tax returns through 2009 and is currently examining the federal income tax returns for 2010 and 2011. In addition, the Company has subsidiaries in Belgium, Brazil, Canada, Denmark, France, Finland, Germany, India, Italy, Japan, Norway, Singapore, Sweden, the United Kingdom and various other countries, states and provinces that are currently under audit for years ranging from 2004 through 2012. Tax authorities in Denmark and Germany have raised significant issues related to the deductibility and taxability of interest accrued by certain of the Company's subsidiaries. On December 10, 2013, the Company received assessments from the Danish tax authority ("SKAT") totaling approximately DKK 1.1 billion (approximately $200 million based on exchange rates as of March 28, 2014) imposing withholding tax and interest thereon relating to interest accrued in Denmark on borrowings from certain of the Company's subsidiaries for the years 2004-2009. If the SKAT claims are successful, it is likely that the Company would be assessed additional amounts through March 2014 totaling approximately DKK 800 million (approximately $150 million based on exchange rates as of March 28, 2014) as well as future interest on the disputed withholding tax for subsequent periods prior to such a determination. Discussions with the German tax authorities are ongoing and final assessments have not been issued. Management believes the positions the Company has taken in both Denmark and Germany are in accordance with the relevant tax laws and intends to vigorously defend its positions, including contesting the SKAT assessment; however, the ultimate resolution of these matters is uncertain, could take many years, and individually or in the aggregate could result in a material adverse impact to the Company's financial statements, including its effective tax rate. The effective tax rate for the balance of 2014 is forecasted to be approximately 24.0% based on the projected mix of earnings before tax by jurisdiction, excluding the impact of any matters that would be treated as "discrete." The actual mix of earnings by jurisdiction could fluctuate from the Company's projection which would impact the Company's effective tax rate for the period. In addition, the tax effects of discrete items, including accruals related to tax contingencies, the resolution of worldwide tax matters, tax audit settlements, statute of limitations expirations and changes in tax regulations, are reflected in the period in which they occur. As a result, it is reasonably possible that the actual effective tax rate used for financial reporting purposes will change in future periods. INFLATION The effect of inflation on the Company's revenues and net earnings was not significant in the three months ended March 28, 2014. 26 -------------------------------------------------------------------------------- Table of Contents |